If you have a huge amount of debt and we mean a huge amount of debt like more than $20,000 and can’t see any possible way to repay it within the next three years then filing for bankruptcy could be your only real option. And yes, a bankruptcy will trash your credit. But if you’re already several months behind on your bills your credit has already been pretty well shredded. This means you have very little to lose if anything by going bankrupt. But before you rush off to hire an attorney there are 8 things you need to know about a bankruptcy.
#1. There are two types of personal bankruptcies
Individuals can take advantage of two types of bankruptcies. They are a chapter 7 and a chapter 13. A chapter 13 bankruptcy is generally called a reorganization bankruptcy because its goal is to help you reorganize your finances and pay off most of your debts. In comparison, a chapter 7 bankruptcy is a liquidation bankruptcy. The way it’s supposed to work is that a bankruptcy judge liquidates your assets and uses the money to repay your creditors. In practice most of your most important assets such as your car, your house and personal possessions are excluded. When you subtract these exclusions there are often no assets left to liquidate. However, bankruptcy laws vary from state to state, which is why you need to think seriously about hiring a bankruptcy attorney instead of trying to do it yourself.
#2. There are debts that will be discharged in a chapter 7
If you have a large number of credit card debts then a chapter 7 bankruptcy could help because it would get them discharged, a fancy way of saying they would be eliminated. Other debts that can be discharged include unsecured loans, car repossessions, deficiency balances, medical bills, judgments and lawsuits, unpaid rent, unpaid utility bills and foreclosure balances. Of course, the most common type of debt for most people is credit card debts and unsecured loans. Examples of these are Visa and MasterCard, department store cards, credit union personal loans, personal loans from a bank or other financial institution, gas cards and payday loans.
#3. There are credit card debts that may not be discharged
If you used a credit card excessively before you filed for bankruptcy, you could have a problem. In this case the creditor could challenge your request to eliminate your entire balance. It could claim that you, in fact, never intended to pay for those items that you charged. If you were to take an expensive vacation or purchase a big-ticket item such as a combination washer dryer before you filed for bankruptcy, you might end up having to pay for those excessive charges.
#4. There are debts that cannot be discharged
It’s important to know that there are some kinds of debts that cannot be discharged in a chapter 7 bankruptcy. Mortgage and auto loans cannot be discharged nor can child support, student loans, alimony, spousal support and certain kinds tax debts. Before you file, you should make a list of your debts that can be discharged versus those that can’t. Then do the math. If you find that the majority of your debts can’t be discharged you might be better off seeking another solution such as consumer credit counseling or a debt consolidation loan.
#5. There are documents you will need to have when you file
You or your attorney will have to go to your county courthouse and file a petition for a Chapter 7 bankruptcy. This must include all relevant paperwork such as pay stubs, debt records, living expenses, tax receipts, proof of credit counseling and a list of your assets. You will be required to pay a fee for filing unless you can prove that your income is substantially below the poverty level. In other words you must be able to prove that given your financial circumstances bankruptcy is your only real option.
#6. You need to understand what a bankruptcy will do to your credit score
The company that invented credit scoring and whose scores the majority of lenders use is FICO. Only it knows for sure what a bankruptcy would do to your credit score because this depends on a number of variables. However, it is believed that a bankruptcy will drop your credit score by its many as 200 points. This could easily take you from having “good” credit to having “bad” credit. Whether a bankruptcy would drop your credit score by 150 points or 200 points the end result is the same. You will have a very difficult time getting any new credit for at least two and maybe as many as three years after your bankruptcy. When you do get new credit it will be very low money, high interest credit. What’s more, the bankruptcy will stay in your credit report for 10 years and in your public file for the rest of your life.
#7. Why your right to a bankruptcy is guaranteed
Our founding fathers actually wrote into our Constitution a guarantee that we could have a bankruptcy. They believed that everyone deserves a fresh start. If you got through your bankruptcy still owning your house and car and with no unsecured debts you would certainly have a fresh start. But what’s equally important is what you do after your fresh start. You should have learned a lesson and treat credit more sensibly in the future. If not, you’re just doomed to more financial catastrophes going forward.
You completed your bankruptcy and saw all your unsecured debts discharged. So what comes next? It should be working to rebuild your credit. One of the best ways to do this is with a secured credit card. This is where you go to a local bank or credit union and give it some amount of money to hold. The bank or credit union then gives you a credit limit equal to that amount of money. For example, if you were to give the bank $500 you would have a credit limit of $500 on that card. Before you sign up for the card and put down the $500 or whatever it’s important to ask if the way you use the card will be reported to the three major credit bureaus. If not, find a different bank or credit union. This is because if you handle that card sensibly you want this reported to the credit bureaus as a way to begin rebuilding your credit. You should also ask how soon you could increase the limit on the card. You’re going to eventually want to deposit more money on that card to increase its limit. The math is simple — the higher your limit and the lower your balance, the quicker your credit score will improved.
Once you have filed for bankruptcy, you may begin to receive offers for unsecured credit cards. This means that you could open the card without giving the financial institution anything. As you might guess, the higher the limit the better. But do be careful about upfront fees. And again you will want to know whether or not the way you handle a card will be reported to the three credit bureaus. Finally, it’s usually very easy to get a retail or gas credit card after bankruptcy and use it – again sensibly – to help rebuild your credit.